UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2007
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from__________ to ____________
Commission File Number 000-20202
CREDIT ACCEPTANCE CORPORATION
(Exact name of registrant as specified in its charter)
MICHIGAN 38-1999511
(State or other jurisdiction of incorporation or organization) (IRS Employer Identification)
25505 WEST TWELVE MILE ROAD, SUITE 3000
SOUTHFIELD, MICHIGAN 48034-8339
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 248-353-2700
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date.
The number of shares of Common Stock, par value $0.01, outstanding on July 26,
2007 was 30,314,956.
TABLE OF CONTENTS
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Income Statements -
Three and six months ended June 30, 2007 and June 30, 2006 1
Consolidated Balance Sheets -
As of June 30, 2007 and December 31, 2006 2
Consolidated Statements of Cash Flows -
Six months ended June 30, 2007 and June 30, 2006 3
Notes to Consolidated Financial Statements 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS 29
ITEM 4. CONTROLS AND PROCEDURES 29
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 30
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 31
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 31
ITEM 6. EXHIBITS 31
SIGNATURES 32
INDEX OF EXHIBITS 33
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED INCOME STATEMENTS
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------------
(Dollars in thousands, except per share data) 2007 2006 2007 2006
------------ ------------ ------------ ------------
REVENUE:
Finance charges $ 54,084 $ 47,919 $ 105,497 $ 93,926
License fees 84 3,204 166 6,101
Other income 4,118 3,958 9,974 8,080
------------ ------------ ------------ ------------
Total revenue 58,286 55,081 115,637 108,107
------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Salaries and wages 13,092 9,965 24,953 20,559
General and administrative 7,359 6,297 13,276 13,062
Sales and marketing 4,144 3,406 8,616 7,765
Provision for credit losses 3,798 2,641 7,671 3,165
Interest 9,463 5,660 17,751 9,234
Other expense 33 55 58 137
------------ ------------ ------------ ------------
Total costs and expenses 37,889 28,024 72,325 53,922
------------ ------------ ------------ ------------
Operating income 20,397 27,057 43,312 54,185
Foreign currency gain 34 6 38 11
------------ ------------ ------------ ------------
Income from continuing operations before provision for
income taxes 20,431 27,063 43,350 54,196
Provision for income taxes 7,938 9,364 15,470 19,292
------------ ------------ ------------ ------------
Income from continuing operations 12,493 17,699 27,880 34,904
------------ ------------ ------------ ------------
Discontinued operations
Loss from discontinued United Kingdom operations (233) (132) (271) (145)
Credit for income taxes (70) (39) (81) (44)
------------ ------------ ------------ ------------
Loss on discontinued operations (163) (93) (190) (101)
------------ ------------ ------------ ------------
Net income $ 12,330 $ 17,606 $ 27,690 $ 34,803
============ ============ ============ ============
Net income per common share:
Basic $ 0.41 $ 0.53 $ 0.92 $ 1.01
============ ============ ============ ============
Diluted $ 0.39 $ 0.50 $ 0.88 $ 0.94
============ ============ ============ ============
Income from continuing operations per common share:
Basic $ 0.41 $ 0.54 $ 0.93 $ 1.01
============ ============ ============ ============
Diluted $ 0.40 $ 0.50 $ 0.89 $ 0.94
============ ============ ============ ============
Loss from discontinued operations per common share:
Basic $ (0.01) $ (0.00) $ (0.01) $ (0.00)
============ ============ ============ ============
Diluted $ (0.01) $ (0.00) $ (0.01) $ (0.00)
============ ============ ============ ============
Weighted average shares outstanding:
Basic 30,140,590 32,979,572 30,097,387 34,554,605
Diluted 31,312,139 35,433,944 31,297,484 37,029,956
See accompanying notes to consolidated financial statements.
1
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED BALANCE SHEETS
AS OF
--------------------------
JUNE 30, DECEMBER 31,
2007 2006
(Dollars in thousands, except per share data) (UNAUDITED)
----------- -----------
ASSETS:
Cash and cash equivalents $ 1,829 $ 8,528
Restricted cash and cash equivalents 72,327 45,609
Restricted securities available for sale 3,763 3,564
Loans receivable (including $17,797 and $23,038 from affiliates as of
June 30, 2007 and December 31, 2006, respectively) 873,441 754,571
Allowance for credit losses (129,282) (128,791)
----------- -----------
Loans receivable, net 744,159 625,780
----------- -----------
Property and equipment, net 17,209 16,203
Income taxes receivable 4,504 11,734
Other assets 12,806 13,795
----------- -----------
Total Assets $ 856,597 $ 725,213
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
LIABILITIES:
Accounts payable and accrued liabilities $ 80,842 $ 78,294
Line of credit 44,500 38,400
Secured financing 432,631 345,144
Mortgage note and capital lease obligations 8,017 8,631
Deferred income taxes, net 50,750 44,397
----------- -----------
Total Liabilities 616,740 514,866
----------- -----------
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value, 1,000,000 shares authorized, none
issued - -
Common stock, $.01 par value, 80,000,000 shares authorized, 30,314,956
and 30,179,959 shares issued and outstanding as of June 30, 2007 and
December 31, 2006, respectively 303 302
Paid-in capital 2,730 828
Retained earnings 236,856 209,253
Accumulated other comprehensive loss, net of tax of $18 and $19 at
June 30, 2007 and December 31, 2006, respectively (32) (36)
----------- -----------
Total Shareholders' Equity 239,857 210,347
----------- -----------
Total Liabilities and Shareholders' Equity $ 856,597 $ 725,213
=========== ===========
See accompanying notes to consolidated financial statements.
2
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
----------------------
(Dollars in thousands) 2007 2006
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 27,690 $ 34,803
Adjustments to reconcile cash provided by operating activities:
Provision for credit losses 7,671 3,165
Depreciation 2,072 2,473
Loss on retirement of property and equipment 72 38
Provision (credit) for deferred income taxes 6,353 (69)
Stock-based compensation 1,845 (54)
Change in operating assets and liabilities:
Accounts payable and accrued liabilities 2,461 2,950
Income taxes receivable 7,230 5,473
Other assets 1,131 (2,271)
--------- ---------
Net cash provided by operating activities 56,525 46,508
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Increase in restricted cash and cash equivalents (26,718) (16,944)
Purchases of restricted securities available for sale (550) (794)
Proceeds from sale of restricted securities available for sale - 251
Maturities of restricted securities available for sale 355 -
Principal collected on loans receivable 306,964 284,244
Advances to dealers and accelerated payments of dealer holdback (350,229) (271,273)
Purchases of consumer loans (43,894) (5,779)
Payments of dealer holdback (38,948) (35,635)
Net change in floorplan receivables, notes receivable and lines
of credit 63 1,611
Purchases of property and equipment (3,028) (689)
--------- ---------
Net cash used in investing activities (155,985) (45,008)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under line of credit 354,700 166,930
Repayments under line of credit (348,600) (168,830)
Proceeds from secured financing 365,000 320,500
Repayments of secured financing (277,513) (220,000)
Principal payments under mortgage note and capital lease obligations (736) (758)
Repurchase of common stock (2,225) (114,311)
Proceeds from stock options exercised 1,027 4,864
Excess tax benefits from stock-based compensation plans 1,256 3,529
--------- ---------
Net cash provided by (used in) financing activities 92,909 (8,076)
--------- ---------
Effect of exchange rate changes on cash (148) (78)
--------- ---------
Net decrease in cash and cash equivalents (6,699) (6,654)
Cash and cash equivalents, beginning of period 8,528 7,090
--------- ---------
Cash and cash equivalents, end of period $ 1,829 $ 436
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 17,768 $ 8,618
Cash paid during the period for income taxes $ 383 $ 10,830
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Property and equipment acquired through capital lease obligations $ 122 $ 238
Issuance of restricted stock, net of forfeitures $ 1 $ 2,808
See accompanying notes to consolidated financial statements.
3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("generally accepted accounting principles" or "GAAP")
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. The results of operations for interim periods
are not necessarily indicative of actual results achieved for full fiscal years.
The consolidated balance sheet at December 31, 2006 has been derived from the
audited financial statements at that date but does not include all the
information and footnotes required by generally accepted accounting principles
for complete financial statements. For further information, refer to the
consolidated financial statements and footnotes thereto included in the Annual
Report on Form 10-K for the year ended December 31, 2006 for Credit Acceptance
Corporation (the "Company", "Credit Acceptance", "we", "our" or "us"). Certain
prior period amounts have been reclassified to conform to the current
presentation.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
2. SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Since 1972, Credit Acceptance has provided auto loans to consumers,
regardless of their credit history. Our product is offered through a nationwide
network of automobile dealers who benefit from sales of vehicles to consumers
who otherwise could not obtain financing; from repeat and referral sales
generated by these same customers; and from sales to customers responding to
advertisements for our product, but who actually end up qualifying for
traditional financing.
Without our product, consumers are often unable to purchase a vehicle or
they purchase an unreliable one and are not provided the opportunity to improve
their credit standing. As we report to the three national credit reporting
agencies, a significant number of our consumers improve their lives by improving
their credit score and move on to more traditional sources of financing.
Credit Acceptance was founded to collect retail installment contracts
(referred to as "Consumer Loans") originated by automobile dealerships owned by
our founder, majority shareholder, and current Chairman, Donald Foss. During the
1980s, we began to market this service to non-affiliated dealers and, at the
same time, began to offer dealers a non-recourse cash payment (referred to as an
"advance") against anticipated future collections on Consumer Loans serviced for
that dealer. Today, our program is offered to dealers throughout the United
States. We refer to dealers who participate in our program and who share our
commitment to changing consumers' lives as "dealer-partners".
A consumer who does not qualify for conventional automobile financing can
purchase a used vehicle from a Credit Acceptance dealer-partner and finance the
purchase through the Company. As payment for the vehicle, the dealer-partner
generally receives the following:
(i) a down payment from the consumer;
(ii) a cash advance from the Company; and
(iii) after the advance has been recovered by the Company, the cash
from payments made on the Consumer Loan, net of certain
collection costs and our servicing fee ("dealer holdback").
Our servicing fee is equal to a fixed percentage (typically 20%) of each
payment collected. In addition, we receive fees for other products and services
provided in connection with Consumer Loans.
If we discover a misrepresentation by the dealer-partner relating to a
Consumer Loan assigned to us, we can demand that the Consumer Loan be
repurchased for the current balance of the Consumer Loan less the amount of any
unearned finance charge plus the applicable termination fee, which is generally
$500. Upon receipt of such amount in full, we will reassign the Consumer Loan
and its security interest in the financed vehicle to the dealer-partner. The
dealer-partner can also opt to repurchase Consumer Loans at their own
discretion.
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
2. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
We are an indirect lender from a legal perspective, meaning the Consumer
Loan is originated by the dealer-partner and immediately assigned to us.
Typically, the compensation paid to the dealer-partner in exchange for the
Consumer Loan is paid in two parts. For the majority of our loans, a portion of
the compensation is paid at the time of origination, and a portion is paid over
time. The amount paid at the time of origination is called an advance; the
portion paid over time based on the performance of the loan is called dealer
holdback.
For accounting purposes, the transactions described above are not
considered to be loans to consumers. Instead, our accounting reflects that of a
lender to the dealer-partner. This classification for accounting purposes is
primarily a result of (i) the dealer-partner's financial interest in the
Consumer Loan and (ii) certain elements of our legal relationship with the
dealer-partner. The cash amount advanced to the dealer-partner (the "Dealer
Loan") is recorded as an asset on our balance sheet. The aggregate amount of all
advances to an individual dealer-partner, plus accrued income, less repayments
comprises the amount of the Dealer Loan recorded in Loans receivable.
A modest percentage of Consumer Loans in the United States are assigned to
us in exchange for a single payment. Because the dealer-partner does not retain
a financial interest in loans acquired in this manner, these loans are
considered to be purchased loans ("Purchased Loans") for accounting purposes.
The Company is organized into two primary business segments: United States
and Other. The Other segment consists of a number of discontinued businesses
including a United Kingdom automobile financing business, an automobile leasing
business, a Canadian automobile financing business, and a business offering
secured lines of credit and floorplan financing products. As of June 30, 2007,
substantially all of our capital was invested in the United States business
segment.
Our business is seasonal with peak Consumer Loan acceptances and
collections occurring during the first quarter of the year. However, this
seasonality does not have a material impact on our interim results.
ACCOUNTING POLICIES
Finance Charges - Dealer Loans. We recognize finance charge income on
Dealer Loans in a manner consistent with the provisions of the American
Institute of Certified Public Accountant's Statement of Position ("SOP") 03-3
"Accounting for Certain Loans or Debt Securities Acquired in a Transfer." SOP
03-3 requires us to recognize finance charges under the interest method such
that revenue is recognized on a level-yield basis based upon forecasted cash
flows. As the forecasted cash flows change, we adjust the yield upwards for
positive changes and recognize impairment for negative changes in the current
period.
Finance Charges - Purchased Loans. We recognize finance charge income on
Purchased Loans consistent with the provisions of SOP 03-3. SOP 03-3 requires us
to recognize finance charges under the interest method such that revenue is
recognized on a level-yield basis based upon forecasted cash flows. As the
forecasted cash flows change, we adjust the yield upwards for positive changes
and recognize impairment for negative changes in the current period.
Finance Charges - Other. Buyers Vehicle Protection Plan, Inc. ("BVPP"), a
wholly owned subsidiary of the Company, has relationships with third party
vehicle service contract administrators ("TPAs") whereby the TPAs process claims
on vehicle service contracts underwritten by third party insurers. BVPP receives
a commission for all such vehicle service contracts sold by our dealer-partners
where the vehicle service contract is financed by us, and does not bear any risk
of loss for claims covered on these third party service contracts. The
commission is included in the purchase price of the vehicle service contract
included in the Consumer Loan. We advance to dealer-partners an amount based on
the purchase price of the vehicle service contract on Consumer Loans accepted by
us that include vehicle service contracts. We recognize the commission received
from the TPAs for contracts financed by us as part of finance charges on a
level-yield basis based upon forecasted cash flows. We also receive a commission
for vehicle service contracts sold by our dealer partners when the underlying
loan is not financed by us. Commissions on contracts not financed by us are
recognized as finance charge income at the time the commissions are received.
Our agreements with two of our TPAs allow us to receive profit sharing payments
depending upon the performance of the vehicle service contract programs. Profit
sharing payments are received once a year, if eligible. Profit sharing payments
are not estimable and therefore revenue related to these payments is recognized
in the period the payments are received.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
2. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
BVPP also allows dealer-partners to offer a Guaranteed Asset Protection
("GAP") product to consumers that is underwritten by a third party. GAP provides
the consumer protection by paying the difference between the loan balance and
the consumer's insurance coverage in the event the vehicle is totaled or stolen.
The dealer-partner typically includes the purchase price of GAP in the Consumer
Loan. We receive a commission for every GAP product sold by our dealer-partners.
We advance to dealer-partners an amount based on the purchase price of the GAP
product on Consumer Loans accepted by us that include GAP. We recognize the
commission as part of finance charges on a level-yield basis based upon
forecasted cash flows. We also receive a commission for contracts sold by our
dealer partners when the underlying loan is not financed by us. Commissions on
contracts not financed by us are recognized as finance charge income at the time
the commissions are received. We are eligible to receive profit sharing payments
depending on the performance of the GAP products sold. Profit sharing payments
from the third party are received once a year, if eligible. Profit sharing
payments are not estimable and therefore revenue related to these payments is
recognized in the period the payments are received.
We charge dealer-partners a monthly license fee for access to our patented
internet-based Credit Approval Processing System ("CAPS"). In accordance with
GAAP, this fee has historically been recorded as revenue in the month the fee is
charged. Based on feedback received from field sales personnel and
dealer-partners, we concluded that the way this fee was charged was a
significant factor driving higher than desired dealer-partner attrition.
Effective January 1, 2007, we implemented a change in the way these fees are
charged designed to positively impact dealer-partner attrition. We continue to
charge a monthly fee of $599 but, instead of collecting the license fee in the
current period, we collect the license fee from future dealer holdback payments
and recognize it as finance charges over the life of the Dealer Loans.
Loans Receivable and Allowance for Credit Losses - Dealer Loans. We record
the amount advanced to the dealer-partner as a Dealer Loan. The Dealer Loan is
increased as revenue is recognized and decreased as collections are received. We
follow an approach similar to the provisions of SOP 03-3 in determining our
allowance for credit losses. Consistent with SOP 03-3, an allowance for credit
losses is maintained at an amount that reduces the net asset value (Dealer Loan
balance less the allowance) to the value of forecasted future cash flows
discounted at the yield established at the inception of the Dealer Loan. This
allowance is calculated on a dealer-partner by dealer-partner basis. The
discounted value of future cash flows is comprised of estimated future
collections on the Consumer Loans, less any estimated dealer holdback payments.
We write off Dealer Loans once there are no forecasted future collections on any
of the associated Consumer Loans.
In estimating future collections and dealer holdback payments for each
dealer-partner, we consider: (i) a dealer-partner's actual collection data on a
static pool basis and (ii) our historical collection experience. Our collection
forecast for each dealer-partner is updated monthly and we take into
consideration the most recent static pool data available for each dealer-partner
and our entire portfolio of Consumer Loans.
Cash flows from any individual Dealer Loan are often different than
estimated cash flows at Dealer Loan inception. If such difference is favorable,
the difference is recognized into income over the remaining life of the Dealer
Loan through a yield adjustment. If such difference is unfavorable, an allowance
for credit losses is established and a corresponding provision for credit losses
is recorded as a current period expense. Because differences between estimated
cash flows at inception and actual cash flows occur often, an allowance is
required for a significant portion of our Dealer Loan portfolio. An allowance
for credit losses does not necessarily indicate that a Dealer Loan is
unprofitable, and in recent years, very seldom are cash flows from a Dealer Loan
insufficient to repay the initial amounts advanced to the dealer-partner.
Loans Receivable and Allowance for Credit Losses - Purchased Loans. We
record the amount paid to the dealer-partner to acquire the Consumer Loan as a
Purchased Loan. The Purchased Loan is increased as revenue is recognized and
decreased as collections are received. We aggregate Purchased Loans into pools
based on the month of purchase for revenue recognition and impairment purposes.
We follow an approach consistent with the provisions of SOP 03-3 in determining
our allowance for credit losses. Under SOP 03-3, an allowance for credit losses
is maintained at an amount that reduces the net asset value (Purchased Loan pool
balance less the allowance) to the value of forecasted future cash flows
discounted at the yield established at the date of purchase. The discounted
value of future cash flows is comprised of estimated future collections on the
pool of Purchased Loans. We write off pools of Purchased Loans once there are no
forecasted future collections on any of the Purchased Loans included in the
pool.
In estimating future collections for each pool of Purchased Loans, we
consider: (i) actual collection data on a static pool basis and (ii) our
historical collection experience. Our collection forecast for each pool of
Purchased Loans is updated monthly and we take into consideration the most
recent static pool data available for our Purchased Loans and our entire
portfolio of Consumer Loans.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
2. SIGNIFICANT ACCOUNTING POLICIES - (CONCLUDED)
Cash flows from any individual pool of Purchased Loans are often different
than estimated cash flows at the date of purchase. If such difference is
favorable, the difference is recognized into income over the remaining life of
the pool of Purchased Loans through a yield adjustment. If such difference is
unfavorable, an allowance for credit losses is established and a corresponding
provision for credit losses is recorded as a current period expense.
NEW ACCOUNTING PRONOUNCEMENTS
In July 2006, the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109" ("FIN
48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized
in an entity's financial statements in accordance with FASB Statement No. 109,
"Accounting for Income Taxes" and prescribes a recognition threshold and
measurement attributes for financial statement disclosure of tax positions taken
or expected to be taken on a tax return. Under FIN 48, the impact of an
uncertain income tax position on the income tax return must be recognized at the
largest amount that is more-likely-than-not to be sustained upon audit by the
relevant taxing authority. An uncertain income tax position will not be
recognized if it has less than a 50% likelihood of being sustained.
Additionally, FIN 48 provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition. FIN 48 is effective for fiscal years beginning after December 15,
2006. We adopted the provisions of FIN 48 on January 1, 2007. The cumulative
effect of implementation of FIN 48 was approximately a $0.1 million increase in
the liability for unrecognized tax benefits, which was accounted for as a
decrease in the January 1, 2007 balance of retained earnings.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities" ("SFAS 159"). SFAS 159 permits
entities to choose to measure financial assets and liabilities (except for those
that are specifically exempted from the Statement) at fair value. The election
to measure a financial asset or liability at fair value can be made on an
instrument-by-instrument basis and is irrevocable. The difference between
carrying value and fair value at the election date is recorded as a transition
adjustment to opening retained earnings. Subsequent changes in fair value are
recognized in earnings. SFAS 159 is effective for fiscal years beginning after
November 15, 2007. We are not yet able to quantify the impact of SFAS 159, if
adopted, on our consolidated financial statements.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
3. LOANS RECEIVABLE
A summary of changes in Loans receivable is as follows (in thousands):
THREE MONTHS ENDED JUNE 30, 2007
---------------------------------------------------------
DEALER LOANS PURCHASED LOANS OTHER LOANS TOTAL
------------ --------------- ----------- -------
Balance, beginning of period $ 797,988 $ 37,171 $ 691 $ 835,850
New loans (1) 138,177 29,770 - 167,947
Dealer holdback payments 18,328 - - 18,328
Net cash collections on loans (139,186) (6,669) - (145,855)
Write-offs (3,028) (30) - (3,058)
Recoveries - 7 - 7
Net change in floorplan receivables, notes
receivable, and lines of credit - - (5) (5)
Other - - 92 92
Currency translation 135 - - 135
------------ --------------- ----------- ---------
Balance, end of period $ 812,414 $ 60,249 $ 778 $ 873,441
============ =============== =========== =========
THREE MONTHS ENDED JUNE 30, 2006
---------------------------------------------------------
DEALER LOANS PURCHASED LOANS OTHER LOANS TOTAL
------------ --------------- ----------- ---------
Balance, beginning of period $ 703,223 $ 16,947 $ 1,211 $ 721,381
New loans (1) 114,627 2,443 - 117,070
Dealer holdback payments 17,991 - - 17,991
Net cash collections on loans (134,223) (2,575) - (136,798)
Write-offs (3,969) (163) - (4,132)
Recoveries - 10 - 10
Net change in floorplan receivables, notes
receivable, and lines of credit - - 278 278
Other - - 79 79
Currency translation 81 - - 81
------------ --------------- ----------- ---------
Balance, end of period $ 697,730 $ 16,662 $ 1,568 $ 715,960
============ =============== =========== =========
SIX MONTHS ENDED JUNE 30, 2007
---------------------------------------------------------
DEALER LOANS PURCHASED LOANS OTHER LOANS TOTAL
------------ --------------- ----------- ---------
Balance, beginning of period $ 724,093 $ 29,926 $ 552 $ 754,571
New loans (1) 350,229 43,894 - 394,123
Dealer holdback payments 38,948 - - 38,948
Net cash collections on loans (293,821) (13,410) - (307,231)
Write-offs (7,183) (180) - (7,363)
Recoveries - 19 - 19
Net change in floorplan receivables, notes
receivable, and lines of credit - - 41 41
Other - - 185 185
Currency translation 148 - - 148
------------ --------------- ----------- ---------
Balance, end of period $ 812,414 $ 60,249 $ 778 $ 873,441
============ =============== =========== =========
SIX MONTHS ENDED JUNE 30, 2006
---------------------------------------------------------
DEALER LOANS PURCHASED LOANS OTHER LOANS TOTAL
------------ --------------- ----------- ---------
Balance, beginning of period $ 675,692 $ 16,486 $ 2,761 $ 694,939
New loans (1) 271,273 5,779 - 277,052
Dealer holdback payments 35,635 - - 35,635
Net cash collections on loans (279,724) (5,424) - (285,148)
Write-offs (5,224) (225) - (5,449)
Recoveries - 46 - 46
Net change in floorplan receivables, notes
receivable, and lines of credit - - (1,389) (1,389)
Other - - 196 196
Currency translation 78 - - 78
------------ --------------- ----------- ---------
Balance, end of period $ 697,730 $ 16,662 $ 1,568 $ 715,960
============ =============== =========== =========
(1) New Dealer Loans includes advances to dealer-partners and accelerated
payments of dealer holdback.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
3. LOANS RECEIVABLE - (CONCLUDED)
A summary of changes in the Allowance for credit losses is as follows (in
thousands):
THREE MONTHS ENDED JUNE 30, 2007
----------------------------------------------
DEALER LOANS PURCHASED LOANS TOTAL
-------------- --------------- -----------
Balance, beginning of period $ 127,191 $ 1,058 $ 128,249
Provision for credit losses (1) 4,151 (178) 3,973
Write-offs (3,028) (30) (3,058)
Recoveries - 7 7
Currency translation 111 - 111
------------ ---------- ----------
Balance, end of period $ 128,425 $ 857 $ 129,282
============ ========== ==========
THREE MONTHS ENDED JUNE 30, 2006
----------------------------------------------
DEALER LOANS PURCHASED LOANS TOTAL
-------------- --------------- -----------
Balance, beginning of period $ 129,543 $ 1,071 $ 130,614
Provision for credit losses (2) 2,475 23 2,498
Write-offs (3,969) (163) (4,132)
Recoveries - 10 10
Currency translation 62 - 62
------------ ---------- ----------
Balance, end of period $ 128,111 $ 941 $ 129,052
============ ========== ==========
SIX MONTHS ENDED JUNE 30, 2007
----------------------------------------------
DEALER LOANS PURCHASED LOANS TOTAL
-------------- --------------- -----------
Balance, beginning of period $ 127,881 $ 910 $ 128,791
Provision for credit losses (3) 7,602 108 7,710
Write-offs (7,183) (180) (7,363)
Recoveries - 19 19
Currency translation 125 - 125
------------ ---------- ----------
Balance, end of period $ 128,425 $ 857 $ 129,282
============ ========== ==========
SIX MONTHS ENDED JUNE 30, 2006
----------------------------------------------
DEALER LOANS PURCHASED LOANS TOTAL
-------------- --------------- -----------
Balance, beginning of period $ 130,722 $ 689 $ 131,411
Provision for credit losses (4) 2,553 431 2,984
Write-offs (5,224) (225) (5,449)
Recoveries - 46 46
Currency translation 60 - 60
------------ ---------- ----------
Balance, end of period $ 128,111 $ 941 $ 129,052
============ ========== ==========
(1) Does not include a negative provision for credit losses of $175 related to
other items.
(2) Does not include a provision for credit losses of $143 related to other
items.
(3) Does not include a negative provision for credit losses of $39 related to
other items.
(4) Does not include a provision for credit losses of $181 related to other
items.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
4. DEBT
We currently use four primary sources of debt financing: (i) a revolving
secured line of credit with a commercial bank syndicate; (ii) a revolving
secured warehouse facility with institutional investors; (iii) SEC Rule 144A
asset-backed secured borrowings ("Term ABS 144A") with qualified institutional
investors; and (iv) a residual credit facility with an institutional investor.
General information for each of the financing transactions outstanding as of
June 30, 2007 is as follows (dollars in thousands):
WHOLLY OWNED ISSUE FINANCING INTEREST RATE AT
FINANCINGS SUBSIDIARY * NUMBER CLOSE DATE MATURITY DATE AMOUNT JUNE 30, 2007
--------------------- ------------------- -------- --------------- ----------------- --------- ----------------------
Revolving Line of n/a n/a June 14, 2007 June 20, 2009 $ 75,000 Either Eurodollar rate
Credit plus 125 basis points
(6.56%) or the prime rate
minus 165 basis points
(6.60%)
Revolving Secured CAC Warehouse 2003-2 February 14, 2007 February 13, $ 325,000 Commercial paper rate
Warehouse Facility* Funding Corp. II 2008 plus 65 basis points
(6.01%)
Term ABS 144A 2006-1* Credit Acceptance 2006-1 April 18, 2006 n/a** $ 100,000 Fixed rate (5.36%)
Funding LLC 2006-1
Term ABS 144A 2006-2* Credit Acceptance 2006-2 November 21, 2006 n/a*** $ 100,000 Fixed rate (5.38%)
Funding LLC 2006-2
Term ABS 144A 2007-1* Credit Acceptance 2007-1 April 12, 2007 n/a**** $ 100,000 Fixed rate (5.32%)
Funding LLC 2007-1
Residual Credit Credit Acceptance 2006-3 September 20, 2006 September 19, $ 50,000 LIBOR or the
Facility* Residual Funding 2007 commercial paper rate
LLC plus 145 basis points
(6.81%)
* Financing made available only to a specified subsidiary of the Company.
** This facility was paid off on July 16, 2007.
*** The total expected term of this facility is 22 months.
**** The total expected term of this facility is 24 months.
Additional information related to the amounts outstanding on each facility is as
follows (dollars in thousands):
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------------------------------------
2007 2006 2007 2006
------------------------------------------------------------
REVOLVING LINE OF CREDIT
Maximum outstanding balance $ 70,200 $ 103,900 $ 70,200 $ 103,900
Weighted average outstanding balance 46,583 66,922 44,549 63,130
REVOLVING SECURED WAREHOUSE FACILITY
Maximum outstanding balance $ 293,500 $ 163,769 $ 293,500 $ 163,769
Weighted average outstanding balance 222,805 121,945 219,736 116,800
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
4. DEBT - (CONTINUED)
AS OF JUNE 30, AS OF DECEMBER 31,
2007 2006
------------- ------------------
REVOLVING LINE OF CREDIT
Balance outstanding $ 44,500 $ 38,400
Letter(s) of credit 400 860
Amount available for borrowing 30,100 95,740
Interest rate 6.60% 7.06%
REVOLVING SECURED WAREHOUSE FACILITY
Balance outstanding $ 227,000 $ 171,000
Amount available for borrowing 98,000 154,000
Contributed Dealer Loans 291,866 249,247
Interest rate 6.01% 6.00%
TERM ABS 144A 2006-1
Balance outstanding $ 5,631 $ 74,144
Contributed Dealer Loans 76,135 115,664
Interest rate 5.36% 5.36%
TERM ABS 144A 2006-2
Balance outstanding $ 100,000 $ 100,000
Contributed Dealer Loans 125,015 125,178
Interest rate 5.38% 5.38%
TERM ABS 144A 2007-1
Balance outstanding $ 100,000 $ -
Contributed Dealer Loans 129,000 -
Interest rate 5.32% -
RESIDUAL CREDIT FACILITY
Balance outstanding $ - $ -
Contributed Dealer Loans - -
Interest rate 6.81% 6.80%
LINE-OF-CREDIT FACILITY
During the second quarter, we extended the maturity of our line-of-credit
facility from June 20, 2008 to June 20, 2009. We also reduced the amount of the
facility from $135.0 million to $75.0 million because the funding available
under this facility and our $325.0 million warehouse facility exceeded our
current revolving credit borrowing needs. In addition, the interest rate on
borrowings under the facility was reduced from the prime rate or 1.30% over the
Eurocurrency rate, at the Company's option to the prime rate minus 1.65% or
1.25% over the Eurocurrency rate, at the Company's option.
Borrowings under the credit facility are subject to a borrowing-base
limitation. This limitation equals 80% of the net book value of Dealer Loans
plus 80% of the net book value of Purchased Loans, less a hedging reserve (not
exceeding $1.0 million), the amount of letters of credit issued under the
line-of-credit, and the amount of other debt secured by the collateral which
secures the line-of-credit. Borrowings under the credit agreement are secured by
a lien on most of our assets. We must pay annual and quarterly fees on the
amount of the facility.
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
4. DEBT - (CONTINUED)
REVOLVING SECURED WAREHOUSE FACILITY
This facility is used to provide financing to our subsidiary CAC Warehouse
Funding Corp. II ("Warehouse Funding"). Under the facility, we convey Dealer
Loans to this subsidiary in return for cash and equity in the subsidiary. In
turn, Warehouse Funding pledges the Dealer Loans as collateral to institutional
investors to secure loans that will fund the cash portion of the purchase price
of the Dealer Loans. The financing provided to Warehouse Funding under the
facility is limited to the lesser of 80% of the net book value of the
contributed Dealer Loans or the facility limit.
The agreement requires that certain amounts outstanding under the facility
be refinanced within 360 days of the most recent renewal. The most recent
renewal occurred on February 14, 2007, while the most recent refinancing
occurred on April 12, 2007. If such financing does not occur, the transaction
will cease to revolve, will amortize as collections are received and, at the
option of the institutional investors, may be subject to acceleration and
foreclosure.
Warehouse Funding is liable for any amounts due under the facility. Even
though Warehouse Funding and the Company are consolidated for financial
reporting purposes, the financing is non-recourse to the Company. As Warehouse
Funding is organized as a separate legal entity from the Company, assets of
Warehouse Funding (including the conveyed Dealer Loans) will not be available to
satisfy the general obligations of the Company. All of Warehouse Funding's
assets have been encumbered to secure its obligations to its creditors.
Interest on borrowings under the facility has been limited to a maximum
rate of 6.75% through interest-rate-cap agreements executed in the first quarter
of 2007. Warehouse Funding pays the Company a monthly servicing fee equal to 6%
of the collections received with respect to the conveyed Dealer Loans. The fee
is paid out of the collections. Except for the servicing fee and holdback
payments due to dealer-partners, the Company does not have any rights in any
portion of such collections.
TERM ABS 144A FINANCINGS
In 2006 and 2007, three of our wholly owned subsidiaries-Credit Acceptance
Funding LLC 2006-1, Credit Acceptance Funding LLC 2006-2 and Credit Acceptance
Funding LLC 2007-1 (the "Funding LLCs") each completed a secured financing
transaction in which they received $100.0 million. In connection with these
transactions, we conveyed Dealer Loans to each Funding LLC for cash and the sole
membership interest in that Funding LLC. In turn, each Funding LLC conveyed the
Dealer Loans to a respective trust that issued $100.0 million in notes to
qualified institutional investors. In each transaction, the notes were rated
"Aaa" by Moody's Investor Service and "AAA" by Standard & Poor's Rating
Services. Financial insurance policies were issued in connection with the
transactions. The policies guarantee the timely payment of interest and ultimate
repayment of principal on the final scheduled distribution date.
Each financing has a specified revolving period during which we may be
required, and are likely, to convey additional Dealer Loans to each Funding LLC.
Each Funding LLC will then convey them to their respective trust, to maintain
the financing at the $100 million level. (The proceeds of the initial Dealer
Loan conveyances to the Funding LLCs were used to purchase Dealer Loans, on an
arm's-length basis, from Warehouse Funding.) At the end of the revolving period,
the debt outstanding under each financing will begin to amortize.
The financings create loans for which the trusts are liable and which are
secured by all the assets of each trust. Such loans are non-recourse to the
Company, even though the trusts, the Funding LLCs and the Company are
consolidated for financial reporting purposes. Because the Funding LLCs are
organized as separate legal entities from the Company, their assets (including
the conveyed Dealer Loans) are not available to satisfy the Company's general
obligations. The Company receives a monthly servicing fee on each financing
equal to 6% of the collections received with respect to the conveyed Dealer
Loans. The fee is paid out of the collections. Aside from the servicing fee and
payments due to dealer-partners, the Company does not receive, or have any
rights in the collections. However, in its capacity as Servicer of the Dealer
Loans, the Company does have a limited right to exercise a "clean-up call"
option to purchase Dealer Loans from the Funding LLCs under certain specified
circumstances. Alternatively, when a trust's underlying indebtedness is paid in
full, either through collections or through a prepayment of the indebtedness,
the trust is to pay any remaining collections over to its Funding LLC as the
sole beneficiary of the trust. The collections will then be available to be
distributed to the Company as the sole member of the respective Funding LLC. The
table below sets forth certain additional details regarding the outstanding Term
ABS 144A Financings.
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
4. DEBT - (CONTINUED)
NET BOOK VALUE OF EXPECTED
TERM ABS 144A ISSUE DEALER LOANS ANNUALIZED
FINANCING NUMBER CLOSE DATE CONVEYED AT CLOSING REVOLVING PERIOD RATES *
-------------------- ------ ------------------ ------------------- -------------------------- -------------
Term ABS 144A 2006-1 2006-1 April 18, 2006 $133,500 6 months 7.6%
(Through October 16, 2006)
Term ABS 144A 2006-2 2006-2 November 21, 2006 $125,600 12 months 7.4%
(Through November 15, 2007)
Term ABS 144A 2007-1 2007-1 April 12, 2007 $125,700 12 months 7.2%
(Through April 15, 2008)
* Includes underwriter's fees, insurance premiums and other costs.
RESIDUAL CREDIT FACILITY
Another wholly owned subsidiary, Credit Acceptance Residual Funding LLC
("Residual Funding"), has a $50.0 million secured credit facility with an
institutional investor. This facility allows Residual Funding to finance its
purchase of trust certificates from special-purpose entities (the "Term SPEs")
that have purchased Dealer Loans under our term securitization transactions.
Historically, the Term SPEs' residual interests in Dealer Loans, represented by
their trust certificates, have proven to have value that increases as their term
securitization obligations amortize. This facility enables the Term SPEs to
realize and distribute to us up to 65% of that increase in value prior to the
time the related term securitization senior notes are paid in full.
Residual Funding's interests in Dealer Loans, represented by its purchased
trust certificates, are subordinated to the interests of term securitization
senior noteholders. However, the entire arrangement is non-recourse to the
Company. Residual Funding is organized as a separate legal entity from the
Company. Therefore its assets, including purchased trust certificates, are not
available to satisfy the Company's general obligations, even though Residual
Funding and the Company are consolidated for financial reporting purposes.
MORTGAGE LOAN
We have a mortgage loan from a commercial bank that is secured by a
first-mortgage lien on our headquarters building and an assignment of all
leases, rents, revenues and profits under all present and future leases of the
building. There was $6.5 million and $6.8 million outstanding on this loan as of
June 30, 2007 and December 31, 2006, respectively. The loan matures on June 9,
2009, bears interest at a fixed rate of 5.35%, and requires monthly payments of
$92,156 and a balloon payment at maturity for the balance of the loan.
CAPITAL LEASE OBLIGATIONS
As of June 30, 2007, we had various capital lease obligations outstanding
for computer equipment, with monthly payments totaling $63,000. The total amount
of capital lease obligations outstanding as of June 30, 2007 and December 31,
2006 was $1.6 million and $1.8 million, respectively. These capital lease
obligations bear interest at rates ranging from 7.23% to 8.71% and have maturity
dates between July 2007 and June 2010.
LETTERS OF CREDIT
Letters of credit are issued by a commercial bank syndicate and reduce
amounts available under our revolving line of credit. As of June 30, 2007 and
December 31, 2006, we had letters of credit outstanding of $0.4 million and $0.9
million, respectively. The letters of credit relate to reinsurance agreements.
The letters of credit expire on May 26, 2008, at which time they will be
automatically extended for a period of one year unless we are notified otherwise
by the commercial bank syndicate.
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
4. DEBT - (CONCLUDED)
DEBT COVENANTS
As of June 30, 2007, we are in compliance with various restrictive debt
covenants that require the maintenance of certain financial ratios and other
financial conditions. The most restrictive covenants require a minimum ratio of
our assets to debt and a minimum ratio of our earnings before interest, taxes
and non-cash expenses to fixed charges. The covenants also limit the maximum
ratio of our funded debt to tangible net worth. Additionally, we must maintain,
as of the end of each quarter, consolidated net income of not less than $1.00
for the two consecutive quarters then ending. Some of the debt covenants may
indirectly limit the payment of dividends on common stock.
5. RELATED PARTY TRANSACTIONS
In the normal course of our business, we have Dealer Loans with affiliated
dealer-partners owned or controlled by: (i) our majority shareholder and
Chairman; (ii) a member of the Chairman's immediate family; and (iii) our former
President, Keith McCluskey. Mr. McCluskey resigned from his position with the
Company effective September 1, 2006. Transactions with Mr. McCluskey are
reported below through December 31, 2006. Our Dealer Loans to affiliated
dealer-partners and nonaffiliated dealer-partners are on the same terms. A
summary of related party Dealer Loan activity is as follows (in thousands):
As of June 30, 2007 As of December 31, 2006
------------------------- -------------------------
Affiliated Affiliated
Dealer Loan % of Dealer Loan % of
balance consolidated balance consolidated
----------- ------------ ----------- ------------
Affiliated Dealer Loan balance $ 17,797 2.2% $ 22,434 3.1%
For the Three Months ended For the Three Months ended
June 30, 2007 June 30, 2006
--------------------------- ---------------------------
Affiliated Affiliated
dealer-partner % of dealer-partner % of
activity consolidated activity consolidated
-------------- ------------ ------------- ------------
New loans $ 2,346 1.7% $ 3,760 3.3%
Affiliated dealer-partner revenue $ 1,195 2.5% $ 1,635 3.6%
Dealer holdback payments $ 466 2.5% $ 862 4.8%
For the Six Months ended For the Six Months ended
June 30, 2007 June 30, 2006
--------------------------- -----------------------------
Affiliated Affiliated
dealer-partner % of dealer-partner % of
activity consolidated activity consolidated
-------------- ------------ ------------- ------------
New loans $6,558 1.9% $9,859 3.6%
Affiliated dealer-partner
revenue $2,413 2.5% $3,229 3.6%
Dealer holdback payments $1,023 2.6% $1,251 3.5%
Beginning in 2002, entities owned by our majority shareholder and Chairman
began offering secured lines of credit to third parties in a manner similar to a
program previously offered by us. In December of 2004, our majority shareholder
and Chairman sold his ownership interest in these entities; however he continues
to have indirect control over these entities and has the right or obligation to
reacquire the entities under certain circumstances until December 31, 2014 or
the repayment of the related purchase money note.
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
6. INCOME TAXES
A reconciliation of the U.S. federal statutory rate to our effective tax
rate, excluding the results of the discontinued United Kingdom operations, is as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------- ----------------
2007 2006 2007 2006
----- ----- ----- ------
U.S. federal statutory rate 35.0% 35.0% 35.0% 35.0%
State income taxes 3.9 (0.8) 4.0 0.2
Other -- 0.4 (3.3) 0.4
---- ---- ---- ----
Effective tax rate 38.9% 34.6% 35.7% 35.6%
==== ==== ==== ====
The differences between the U.S. federal statutory rate and our
consolidated effective tax rate are primarily related to state income taxes and
reserves for uncertain tax positions that are included in the provision for
income taxes. The effective tax rate of 34.6% for the three months ended June
30, 2006 was lower than 38.9% for the three months ended June 30, 2007 due to a
reduction of state tax liability as a result of a settlement during the second
quarter of 2006.
We adopted FIN 48 on January 1, 2007. As a result of the implementation,
we recognized a $0.1 million increase to reserves for uncertain tax positions.
This increase was accounted for as an adjustment to the beginning balance of
retained earnings on the balance sheet. Including the cumulative effect of FIN
48 implementation, at the beginning of 2007, we had approximately $10.0 million
of total gross unrecognized tax benefit that, if recognized, would favorably
affect the effective income tax rate in future periods. During the three and six
months ended June 30, 2007, we recorded additional increases in the unrecognized
tax benefit of $0.7 million and $1.2 million that resulted in a total of $11.2
million of gross unrecognized benefit as of June 30, 2007.
We are subject to U.S. federal income tax as well as income tax in
multiple state jurisdictions. We have substantially concluded all U.S. federal
income tax matters for years through 2001. Substantially all material state and
local tax matters have been concluded for years through 2002 and foreign tax
matters have been concluded through 2000. The federal income tax returns for
2004 and 2005 are currently under examination. The examination began during the
first quarter of 2007 and we believe that it is unlikely to be completed by the
end of 2007.
We recognize interest and penalties related to income tax matters in
provision for income taxes expense. As of January 1, 2007, upon the FIN 48
implementation, we had approximately $2.1 million and $0.9 million of accrued
interest and penalties, respectively, related to uncertain tax positions. During
the three months and six month ended June 30, 2007, we recorded an additional
$0.3 million and $0.4 million of interest and $0.1 million and $0.2 million of
penalties, respectively, related to uncertain tax matters.
15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
7. CAPITAL TRANSACTIONS
NET INCOME PER SHARE
Basic net income per share has been computed by dividing net income by the
weighted average number of common shares outstanding. Diluted net income per
share has been computed by dividing net income by the total of the weighted
average number of common shares and dilutive common stock equivalents
outstanding. Dilutive common stock equivalents included in the computation
represent shares issuable upon assumed exercise of stock options that would have
a dilutive effect using the treasury stock method. The share effect is as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
2007 2006 2007 2006
---------- ---------- ---------- ----------
Weighted average common shares outstanding 30,140,590 32,979,572 30,097,387 34,554,605
Common stock equivalents 1,171,549 2,454,372 1,200,097 2,475,351
---------- ---------- ---------- ----------
Weighted average common shares and common stock equivalents 31,312,139 35,433,944 31,297,484 37,029,956
========== ========== ========== ==========
There were no stock options that would be anti-dilutive for the three and six
months ended June 30, 2007 or the three and six months ended June 30, 2006.
STOCK COMPENSATION PLANS
Pursuant to our Incentive Compensation Plan (the "Incentive Plan"), which
was approved by shareholders on May 13, 2004, we reserved 1.0 million shares of
our common stock for the future granting of restricted stock, restricted stock
units, stock options, and performance awards to employees, officers, and
directors at any time prior to April 1, 2014.
During the six months ended June 30, 2007, we granted 56,669 shares of
restricted stock to employees and officers under the Incentive Plan, all of
which vest over a three year period. During the six months ended June 30, 2007,
637 restricted stock shares vested. At June 30, 2007 and December 31, 2006, we
had 202,626 and 146,028 shares of restricted stock outstanding, respectively.
Shares available for future grants under the Incentive Plan totaled 497,303 at
June 30, 2007. We recognized $0.4 million and $0.4 million of expense related to
restricted stock grants during the three and six months ended June 30, 2007.
On February 22, 2007, the Compensation Committee approved an award of
300,000 restricted stock units to our Chief Executive Officer. Each restricted
stock unit represents and has a value equal to one share of our common stock.
The restricted stock units will be earned over a five year period based upon the
annual increase in our adjusted economic profit. Any earned shares will be
distributed on February 22, 2014. We recognized $1.0 million and $1.4 million of
expense related to the award of restricted stock units during the three and six
months ended June 30, 2007, respectively.
STOCK REPURCHASES
Our board of directors approved a stock repurchase program which
authorizes us to purchase common shares in the open market or in privately
negotiated transactions at price levels we deem attractive. On May 24, 2007, our
board of directors authorized the repurchase of up to $30 million of our common
stock in addition to the board's prior authorizations. As of June 30, 2007, we
have authorization to repurchase up to $36.4 million of our common stock. As of
June 30, 2007, we have repurchased approximately 20.1 million shares under the
stock repurchase program at a cost of $391.9 million. Included in the stock
repurchases to date are 12.5 million shares of common stock purchased through
four modified Dutch auction tender offers at a cost of $304.4 million.
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONCLUDED)
(UNAUDITED)
8. BUSINESS SEGMENT INFORMATION
We have two reportable business segments: United States and Other. The
United States segment primarily consists of the United States automobile
financing business. The Other segment consists of the following: a United
Kingdom automobile financing business, an automobile leasing business, a
Canadian automobile financing business and a business that provided secured
lines of credit and floorplan financing. We are currently liquidating all
businesses classified in the Other segment.
Selected segment information is set forth below (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
2007 2006 2007 2006
-------- -------- -------- --------
Revenue:
United States $ 58,249 $ 54,867 $115,562 $107,909
Other 37 214 75 198
-------- -------- -------- --------
Total revenue $ 58,286 $ 55,081 $115,637 $108,107
======== ======== ======== ========
Income from continuing operations before provision for income taxes:
United States $ 20,324 $ 26,851 $ 43,248 $ 54,063
Other 107 212 102 133
-------- -------- -------- --------
Total income from continuing operations before provision for income taxes $ 20,431 $ 27,063 $ 43,350 $ 54,196
======== ======== ======== ========
AS OF AS OF
JUNE 30, 2007 DECEMBER 31, 2006
------------- -----------------
Segment Assets
United States $ 855,653 $ 724,008
Other 944 1,205
------------- -------------
Total Assets $ 856,597 $ 725,213
============= =============
9. DEBT ISSUANCE COSTS
As of June 30, 2007 and December 31, 2006, deferred debt issuance costs
were $2.2 million (net of amortization expense of $5.2 million) and $3.0 million
(net of amortization expense of $4.1 million), respectively. Expenses associated
with the issuance of debt instruments are capitalized and amortized as interest
expense over the term of the debt instrument on a level-yield basis for term
secured financings and on a straight-line basis for lines of credit and
revolving secured financings.
10. COMPREHENSIVE INCOME
Our comprehensive income information is set forth below (in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
2007 2006 2007 2006
-------- -------- -------- --------
Net income $ 12,330 $ 17,606 $ 27,690 $ 34,803
Unrealized (loss) gain on securities available for
sale (7) (9) 4 (28)
-------- -------- -------- --------
Comprehensive income $ 12,323 $ 17,597 $ 27,694 $ 34,775
======== ======== ======== ========
17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXECUTIVE SUMMARY
Since 1972, we have provided auto loans to consumers, regardless of their
credit history. Our product is offered through a nationwide network of
automobile dealers who benefit from sales of vehicles to consumers who otherwise
could not obtain financing; from repeat and referral sales generated by these
same customers; and from sales to customers responding to advertisements for our
product, but who actually end up qualifying for traditional financing.
We are an indirect lender from a legal perspective, meaning the Consumer
Loan is originated by the dealer-partner and immediately assigned to us.
Typically, the compensation paid to the dealer-partner in exchange for the
Consumer Loan is paid in two parts. For the majority of our loans, a portion of
the compensation is paid at the time of origination, and a portion is paid over
time. The amount paid at the time of origination is called an advance; the
portion paid over time based on the performance of the loan is called dealer
holdback.
For accounting purposes, the transactions described above are not
considered to be loans to consumers. Instead, our accounting reflects that of a
lender to the dealer-partner. This classification for accounting purposes is
primarily a result of (i) the dealer-partner's financial interest in the
Consumer Loan and (ii) certain elements of our legal relationship with the
dealer-partner. The cash amount advanced to the dealer-partner is recorded as an
asset on our balance sheet. The aggregate amount of all advances to an
individual dealer-partner, plus accrued income, less repayments comprises the
amount of the Dealer Loan recorded in Loans receivable.
A modest percentage of Consumer Loans in the United States are assigned to
us in exchange for a single payment at the time of origination. Because the
dealer-partner does not retain a financial interest in loans acquired in this
manner, these loans are considered to be Purchased Loans for accounting
purposes.
Critical success factors for us include access to capital and the ability
to accurately forecast Consumer Loan performance. Our strategy for accessing the
capital required to grow is to: (i) maintain consistent financial performance,
(ii) maintain modest financial leverage, and (iii) maintain multiple funding
sources. Our funded debt to equity ratio is 2:1 at June 30, 2007. We currently
fund our business through four primary sources of financing: (i) a revolving
secured line of credit with a commercial bank syndicate; (ii) a revolving
secured warehouse facility with institutional investors; (iii) Rule 144A asset
backed securitizations with qualified institutional investors; and (iv) a
residual credit facility.
The ability to accurately forecast Consumer Loan performance is critical.
At the time of Consumer Loan acceptance, we forecast future expected cash flows
from the Consumer Loan. Based on these forecasts, an advance is made to the
related dealer-partner at a level designated to achieve an acceptable return on
capital. If Consumer Loan performance equals or exceeds our original
expectation, it is likely our target return on capital will be achieved.
18
CONSUMER LOAN PERFORMANCE
Although the majority of loan originations are recorded in our financial
statements as Dealer Loans, each transaction starts with a loan from the
dealer-partner to the individual purchasing the vehicle. Since the cash flows
available to repay the Dealer Loans are generated, in most cases, from the
underlying Consumer Loan, the performance of the Consumer Loans is critical to
our financial results. The following table presents forecasted Consumer Loan
collection rates, advance rates, the spread (the forecasted collection rate less
the advance rate), and the percentage of the forecasted collections that have
been realized as of June 30, 2007. Payments of dealer holdback and accelerated
payments of dealer holdback are not included in the advance percentage paid to
the dealer-partner. All amounts are presented as a percentage of the initial
balance of the Consumer Loan (principal + interest).
As of June 30, 2007
------------------------------------------------------
Year of Forecasted % of Forecast
Origination Collection % Advance % Spread % Realized
----------- ------------ --------- -------- -------------
1997 58.4% 47.9% 10.5% 99.9%
1998 67.5% 46.1% 21.4% 99.5%
1999 72.4% 48.7% 23.7% 98.7%
2000 72.9% 47.9% 25.0% 98.0%
2001 67.8% 46.0% 21.8% 97.3%
2002 71.0% 42.2% 28.8% 97.0%
2003 74.4% 43.4% 31.0% 96.3%
2004 74.0% 44.0% 30.0% 88.9%
2005 74.1% 46.9% 27.2% 74.5%
2006 70.7% 46.6% 24.1% 39.9%
2007 70.4% 46.4% 24.0% 7.2%
Accurately forecasting future collection rates is critical to our success.
The risk of a forecasting error declines as Consumer Loans age. For example, the
risk of a material forecasting error for business written in 1999 is very small
since 98.7% of the total amount forecasted has already been realized. In
contrast, our forecast for recent Consumer Loans is less certain. If we produce
disappointing operating results, it will likely be because we overestimated
future Consumer Loan performance. Although we believe our forecasted collection
rates are as accurate as possible, there can be no assurance that our estimates
will be accurate or that Consumer Loan performance will be as expected.
A wider spread between the forecasted collection rate and the advance rate
reduces our risk of credit losses. Because collections are applied to advances
on an individual dealer-partner basis, a wide spread does not eliminate the risk
of losses, but it does reduce the risk significantly. While the spread has
decreased from 2003 to 2007, we believe it is still at a sufficient level to
minimize our risk of being able to recover the cash advance.
The following tables compare our forecast of Consumer Loan collection
rates as of June 30, 2007 with the forecast as of March 31, 2007 and as of
December 31, 2006:
June 30, 2007 March 31, 2007
Loan Origination Year Forecasted Collection % Forecasted Collection % Variance
--------------------- ----------------------- ----------------------- --------
1997 58.4% 58.4% 0.0 %
1998 67.5% 67.4% 0.1 %
1999 72.4% 72.4% 0.0 %
2000 72.9% 72.9% 0.0 %
2001 67.8% 67.8% 0.0 %
2002 71.0% 70.8% 0.2 %
2003 74.4% 74.3% 0.1 %
2004 74.0% 74.1% (0.1)%
2005 74.1% 74.0% 0.1 %
2006 70.7% 71.0% (0.3)%
19
June 30, 2007 December 31, 2006
Loan Origination Year Forecasted Collection % Forecasted Collection % Variance
--------------------- ----------------------- ----------------------- --------
1997 58.4% 58.4% 0.0 %
1998 67.5% 67.5% 0.0 %
1999 72.4% 72.4% 0.0 %
2000 72.9% 73.0% (0.1)%
2001 67.8% 67.7% 0.1 %
2002 71.0% 70.7% 0.3 %
2003 74.4% 74.2% 0.2 %
2004 74.0% 73.9% 0.1 %
2005 74.1% 74.2%* (0.1)%
2006 70.7% 71.1%* (0.4)%
2007 70.4% 69.9%** 0.5 %
* These forecasted collection percentages differ from those previously
reported in our Annual Report on Form 10-K for the year ended December 31,
2006 and our 2006 earnings release as they have been revised for a
seasonality factor. This seasonality factor was first applied during the
first quarter of 2007. The following table compares our forecast of
Consumer Loan collection rates as of June 30, 2007, with the forecast as
of December 31, 2006 without the revised seasonality factors:
Loan Origination Year June 30, 2007 December 31, 2006 Variance
--------------------- ------------- ----------------- --------
2005 74.2% 73.8% 0.4 %
2006 70.8% 70.5% 0.3 %
Forecasted collection percentages prior to 2005 are not materially impacted
by the seasonality factors.
** Collection percentage represents the initial forecasted collection
percentage determined at origination for 2007 originations.
Collection results were generally consistent with our expectations.
We modified our loan pricing model during the third quarter of 2006. As a
result, loan originations during the three and six months ended June 30, 2007
are larger, have a lower return on capital, and have a smaller spread than loans
originated during the same periods in 2006. Consumer Loan unit volume also
increased during these periods and we believe this higher volume was primarily
due to the pricing modification.
There were no other material changes in our credit policy or pricing
during 2007 that impacted the financial results for the three and six months
ended June 30, 2007, other than routine changes designed to maintain
profitability levels.
20
RESULTS OF OPERATIONS
Three and Six Months Ended June 30, 2007 Compared to Three and Six Months
Ended June 30, 2006
The following is a discussion of the results of operations and income
statement data for the Company on a consolidated basis.
THREE MONTHS THREE MONTHS
ENDED ENDED
JUNE 30, % OF JUNE 30, % OF
(Dollars in thousands, except per share data) 2007 REVENUE 2006 REVENUE
------------ ------- ------------ -------
REVENUE:
Finance charges $ 54,084 92.8% $ 47,919 87.0%
License fees 84 0.1 3,204 5.8
Other income 4,118 7.1 3,958 7.2
----------- ----- ----------- -----
Total revenue 58,286 100.0 55,081 100.0
COSTS AND EXPENSES:
Salaries and wages 13,092 22.5 9,965 18.1
General and administrative 7,359 12.6 6,297 11.4
Sales and marketing 4,144 7.1 3,406 6.2
Provision for credit losses 3,798 6.5 2,641 4.8
Interest 9,463 16.2 5,660 10.3
Other expense 33 0.1 55 0.1
----------- ----- ----------- -----
Total costs and expenses 37,889 65.0 28,024 50.9
----------- ----- ----------- -----
Operating income 20,397 35.0 27,057 49.1
Foreign currency gain 34 0.1 6 -
----------- ----- ----------- -----
Income from continuing operations before provision for income taxes 20,431 35.1 27,063 49.1
Provision for income taxes 7,938 13.6 9,364 17.0
----------- ----- ----------- -----
Income from continuing operations 12,493 21.5 17,699 32.1
----------- ----- ----------- -----
Discontinued operations
Loss from discontinued United Kingdom operations (233) (0.4) (132) (0.2)
Credit for income taxes (70) (0.1) (39) (0.1)
----------- ----- ----------- -----
Loss on discontinued operations (163) (0.3) (93) (0.1)
----------- ----- ----------- -----
Net income $ 12,330 21.2% $ 17,606 32.0%
=========== ===== =========== =====
Net income per common share:
Basic $ 0.41 $ 0.53
=========== ===========
Diluted $ 0.39 $ 0.50
=========== ===========
Income from continuing operations per common share:
Basic $ 0.41 $ 0.54
=========== ===========
Diluted $ 0.40 $ 0.50
=========== ===========
Loss from discontinued operations per common share:
Basic $ (0.01) $ (0.00)
=========== ===========
Diluted $ (0.01) $ (0.00)
=========== ===========
Weighted average shares outstanding:
Basic 30,140,590 32,979,572
Diluted 31,312,139 35,433,944
21
RESULTS OF OPERATIONS
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, % OF JUNE 30, % OF
(Dollars in thousands, except per share data) 2007 REVENUE 2006 REVENUE
------------ ------- ------------ -------
REVENUE:
Finance charges $ 105,497 91.3% $ 93,926 86.9%
License fees 166 0.1 6,101 5.6
Other income 9,974 8.6 8,080 7.5
----------- ----- ----------- -----
Total revenue 115,637 100.0 108,107 100.0
COSTS AND EXPENSES:
Salaries and wages 24,953 21.4 20,559 19.1
General and administrative 13,276 11.5 13,062 12.1
Sales and marketing 8,616 7.5 7,765 7.2
Provision for credit losses 7,671 6.6 3,165 2.9
Interest 17,751 15.4 9,234 8.5
Other expense 58 0.1 137 0.1
----------- ----- ----------- -----
Total costs and expenses 72,325 62.5 53,922 49.9
----------- ----- ----------- -----
Operating income 43,312 37.5 54,185 50.1
Foreign currency gain 38 - 11 -
----------- ----- ----------- -----
Income from continuing operations before provision for income taxes 43,350 37.5 54,196 50.1
Provision for income taxes 15,470 13.4 19,292 17.8
----------- ----- ----------- -----
Income from continuing operations 27,880 24.1 34,904 32.3
----------- ----- ----------- -----
Discontinued operations
Loss from discontinued United Kingdom operations (271) (0.2) (145) (0.1)
Credit for income taxes (81) - (44) -
----------- ----- ----------- -----
Loss on discontinued operations (190) (0.2) (101) (0.1)
----------- ----- ----------- -----
Net income $ 27,690 23.9% $ 34,803 32.2%
=========== ===== =========== =====
Net income per common share:
Basic $ 0.92 $ 1.01
=========== ===========
Diluted $ 0.88 $ 0.94
=========== ===========
Income from continuing operations per common share:
Basic $ 0.93 $ 1.01
=========== ===========
Diluted $ 0.89 $ 0.94
=========== ===========
Loss from discontinued operations per common share:
Basic $ (0.01) $ (0.00)
=========== ===========
Diluted $ (0.01) $ (0.00)
=========== ===========
Weighted average shares outstanding:
Basic 30,097,387 34,554,605
Diluted 31,297,484 37,029,956
22
For the three months ended June 30, 2007, net income decreased to $12.3
million, or $0.39 per diluted share, compared to $17.6 million, or $0.50 per
diluted share, for the same period in 2006. The decrease in net income primarily
reflects the following:
- The average size of our loan portfolio grew 23.3%. Finance charges
grew by 12.9%. Finance charges grew slower than loans receivable as
a result of pricing changes implemented during the third quarter of
2006.
- Operating expenses increased 25.1%, primarily due to costs
associated with additional headcount to support our growth as well
as increased stock compensation expense.
- We increased our use of debt through share repurchases. The average
ratio of debt to equity for the three months increased from 0.9 to
2.0. Increased debt levels caused interest expense to increase $3.8
million.
- We changed how we account for our license fees due to changing our
methodology of collecting fees from our dealer-partners. This change
reduced revenue by $2.7 million.
For the six months ended June 30, 2007, net income decreased to $27.7
million, or $0.88 per diluted share, compared to $34.8 million, or $0.94 per
diluted share, for the same period in 2006. The decrease in net income primarily
reflects the following:
- The average size of our loan portfolio grew 19.3%. Finance charges
grew by 12.3%. Finance charges grew slower than loans receivable as
a result of pricing changes implemented during the third quarter of
2006.
- Operating expenses increased 13.2%, primarily due to costs
associated with additional headcount to support the growth as well
as increased stock compensation expense.
- We increased our use of debt through share repurchases. The average
ratio of debt to equity for the six months increased from 0.7 to
2.0. Increased debt levels caused interest expense to increase $8.5
million.
- We changed how we account for our license fees due to changing our
methodology of collecting fees from our dealer-partners. This change
reduced revenue by $5.3 million.
Finance Charges. The increase for the three months was primarily due to a
23.3% increase in the average size of the combined Dealer and Purchased Loan
portfolio as a result of an increase in the number of active dealer-partners and
an increase in the average loan size. The increase was partially offset by a 270
basis point decrease in the combined average yield on Dealer and Purchased Loans
primarily due to pricing changes implemented during the third quarter of 2006.
The increase for the six months was primarily due to a 19.3% increase in the
average size of the combined Dealer and Purchased Loan portfolio as a result of
an increase in the number of active dealer-partners and an increase in the
average loan size. The increase was partially offset by a 180 basis point
decrease in the combined average yield on Dealer and Purchased Loans primarily
due to pricing changes implemented during the third quarter of 2006.
The following table summarizes the changes in active dealer-partners and
corresponding Consumer Loan unit volume for the three months ended June 30, 2007
and 2006:
THREE MONTHS ENDED JUNE 30,
---------------------------
2007 2006 % CHANGE
------- ------ --------
Consumer Loan unit volume 25,053 20,176 24.2%
Active dealer-partners (1) 1,955 1,510 29.5%
------ ------
Average volume per dealer-partner 12.8 13.4 -4.5%
Consumer Loan unit volume from dealer-partners active both periods 15,967 15,898 0.4%
Dealer-partners active both periods 1,022 1,022 0.0%
------ ------
Average volume per dealer-partner active both periods 15.6 15.6 0.0%
Consumer Loan unit volume from new dealer-partners 4,331 1,085 299.2%
New active dealer-partners (2) 536 188 185.1%
------ ------
Average volume per new active dealer-partner 8.1 5.8 39.7%
Attrition (3) -21.2% -19.9%
(1) Active dealer-partners are dealer-partners who submit at least one
Consumer Loan during the period.
(2) New active dealer-partners are dealer-partners that have enrolled in our
program and have submitted their first Consumer Loan to us during the
period.
23
(3) Attrition is measured according to the following formula: decrease in
Consumer Loan unit volume from dealer-partners who submitted at least one
Consumer Loan during the comparable period of the prior year but who
submitted no Consumer Loans during the current period divided by prior
year comparable period Consumer Loan unit volume.
Dealer-partners that enroll in our program have the option to pay an
initial $9,850 enrollment fee or can defer their fee. Dealer-partners choosing
the latter option agree to allow us to keep 50% of the first accelerated dealer
holdback payment. This payment, called Portfolio Profit Express, is paid to
qualifying dealer-partners after 100 Consumer Loans have been originated and
assigned to us. While we will lose enrollment fee revenue on those
dealer-partners choosing this option and not reaching 100 Consumer Loans or
otherwise failing to qualify for a Portfolio Profit Express payment, we estimate
that we will realize higher per dealer-partner enrollment fee revenue from those
dealer-partners choosing this option and qualifying for a Portfolio Profit
Express payment. Based on the historical average of Portfolio Profit Express
payments, we expect average enrollment fee revenue per dealer-partner for those
dealer-partners electing the deferred option and reaching 100 Consumer Loans
will be approximately $13,000. Through June 30, 2007, 56 dealer-partners that
have enrolled under the deferred option have earned Portfolio Profit Express
payments. Half of these payments averaged $13,000 per dealer-partner.
Approximately 80% of the dealer-partners that enrolled during the second quarter
of 2007 took advantage of the deferred enrollment option.
License Fees. License fees represent CAPS fees charged to dealer-partners
on a monthly basis. The decreases were primarily due to a change in our method
of collecting the monthly CAPS fee. Effective January 1, 2007, we implemented a
change designed to positively impact dealer-partner attrition. We continue to
charge a monthly fee of $599, but instead of collecting and recognizing the
revenue from the fee in the current period, we collect it from future dealer
holdback payments. As a result of this change, we now record license fees as a
yield adjustment, recognizing these fees as finance charge revenue over the term
of the Dealer Loan. We recognized a small amount of license fee revenue related
to dealer-partners originating Purchased Loans. The decreases in license fees
were partially offset by increases in finance charges of $0.4 million and $0.6
million for the three and six months as a result of this change.
To allow shareholders to more precisely track our financial performance
and make comparisons between periods possible, we will provide non-GAAP adjusted
license fees reflecting the amount of revenue that would have been recognized if
the license fees had always been recorded as a yield adjustment. For the three
and six months ended June 30, 2007 and 2006, total revenue would have changed as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------- ----------------------
(Dollars in thousands) 2007 2006 2007 2006
--------- --------- --------- ---------
Total revenue $ 58,286 $ 55,081 $ 115,637 $ 108,107
License fee yield adjustment 1,816 (968) 4,300 (2,019)
--------- --------- --------- ---------
Adjusted total revenue $ 60,102 $ 54,113 $ 119,937 $ 106,088
========= ========= ========= =========
Other Income. The increase for the six months is primarily related to
profit sharing payments received from ancillary product providers during the
first quarter of 2007. The amounts received in the first quarter of 2007 are the
first profit sharing amounts we have received under this arrangement. Future
payments of this kind are not estimable, and will therefore be recorded as
revenue when received. No additional payments are expected in 2007. The increase
for the six months is also due to interest earnings on restricted cash related
to the Company's secured borrowings.
Salaries and Wages. The increases in salaries and wages, as a percentage
of revenue, for the three and six months were primarily due to an increase in
stock compensation expense primarily related to restricted stock awards granted
in the first quarter of 2007 and an increase in servicing salaries, as a
percentage of revenue, as a result of an increase in headcount due to loan
volume growing at a faster rate than revenue.
General and Administrative. The increase, as a percentage of revenue, for
the three months was primarily due to an increase in data processing and other
expenses related to investments in new systems and processes to support growth
initiatives. These increases were partially offset by a decrease in depreciation
expense due to a decrease in the depreciable asset base. The decrease, as a
percentage of revenue, for the six months, was primarily due to a decrease in
depreciation expense partially offset by an increase in data processing
expenses.
Sales and Marketing. The increases, as a percentage of revenue, for the
three and six months were primarily due to an increase in sales commissions as a
result of an increase in Consumer Loan unit volume partially offset by a
decrease in dealer-partner support products and services expenses as a result of
less utilization of these services by our dealer-partners.
24
Provision for Credit Losses. The increases in the provision for the three
months and six months were primarily due to increases in the provision for
credit losses required to reduce the carrying value of the Dealer Loans to
maintain the initial yield established at the inception of each Dealer Loan.
Interest. The increases for the three and six months were primarily due to
increases in the amount of average outstanding debt as a result of borrowings
used to fund stock repurchases during 2006 and new Dealer Loan originations. The
increases in interest expense were partially offset by the decreased impact of
fixed fees on our secured financings and line of credit facility primarily due
to higher outstanding borrowings.
Provision for Income Taxes. The effective tax rate increased to 38.9% from
34.6% for the three months ended June 30, 2007 and remained comparable at 35.7%
and 35.6% for the six months ended June 30, 2007 and June 30, 2006,
respectively. The increase for the three months was primarily due to a reduction
of state tax liability as a result of a settlement during the second quarter of
2006.
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of capital are cash flows from operating activities,
collections of Consumer Loans and borrowings through four primary sources of
financing: (i) a revolving secured line of credit with a commercial bank
syndicate; (ii) a revolving secured warehouse facility with institutional
investors; (iii) Rule 144A asset backed securitizations with qualified
institutional investors; and (iv) a residual credit facility. Our principal need
for capital is to fund Dealer Loan and Purchased Loan originations, for the
payment of dealer holdback, and to fund stock repurchases. In addition, on
February 9, 2007 we signed a Memorandum of Understanding to settle a consumer
class action lawsuit discussed in Part II Item 1 of this Report. We have agreed
to pay $12.5 million in full and final settlement of all claims against the
Company. The settlement remains subject to court approval.
Our cash and cash equivalents decreased to $1.8 million as of June 30,
2007 from $8.5 million at December 31, 2006. Our total balance sheet
indebtedness increased to $485.1 million at June 30, 2007 from $392.2 million at
December 31, 2006. This increase was primarily a result of borrowings used to
fund new loan originations in 2007.
Restricted Cash and Cash Equivalents increased to $72.3 million as of June
30, 2007 from $45.6 million at December 31, 2006. The balance consists of: i)
$44.7 million of cash collections related to secured financings, ii) $15.0
million of cash held in trusts for future vehicle service claims, and iii) $12.6
million held in escrow related to the Memorandum of Understanding mentioned
above. The claims reserve associated with the trusts and the $12.6 million
related to the settlement are included in accounts payable and accrued
liabilities in the consolidated balance sheets.
25
RESTRICTED SECURITIES
Restricted securities consist primarily of cash related to amounts held in
trusts for future vehicle service contract claims. We determine the appropriate
classification of our investments in debt and equity securities at the time of
purchase and reevaluate such determinations at each balance sheet date. Debt
securities for which we do not have the intent or ability to hold to maturity
are classified as available for sale, and stated at fair value with unrealized
gains and losses, net of income taxes included in the determination of
comprehensive income and reported as a component of shareholders' equity.
Restricted securities available for sale consisted of the following:
AS OF JUNE 30, 2007
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
(in thousands) COST GAINS LOSSES FAIR VALUE
------- ---------- ---------- ----------
US Government and agency securities $ 1,930 $ - $ (8) $ 1,922
Corporate bonds 1,883 - (42) 1,841
------- ------- ------ --------
Total restricted securities available for sale $ 3,813 $ - $ (50) $ 3,763
======= ======= ====== ========
AS OF DECEMBER 31, 2006
----------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
------- ---------- ---------- ----------
US Government and agency securities $ 1,578 $ - $ (8) $ 1,570
Corporate bonds 2,041 - (47) 1,994
------- ------- ------- --------
Total restricted securities available for sale $ 3,619 $ - $ (55) $ 3,564
======= ======= ======= ========
The cost and estimated fair values of securities available for sale by
contractual maturity as of the dates shown are set forth in the table below
(securities with multiple maturity dates are classified in the period of final
maturity). Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
AS OF JUNE 30, 2007 AS OF DECEMBER 31, 2006
---------------------- -----------------------
ESTIMATED ESTIMATED
(in thousands) COST FAIR VALUE COST FAIR VALUE
------- ---------- ------- -----------
Contractual Maturity
Within one year $ 842 $ 847 $ 898 $ 893
Over one year to five years 2,971 2,916 2,721 2,671
Over five years to ten years - - - -
Over ten years - - - -
------- ------- ------- -------
Total restricted securities available for sale $ 3,813 $ 3,763 $ 3,619 $ 3,564
======= ======= ======= =======
26
CONTRACTUAL OBLIGATIONS
In addition to the balance sheet indebtedness as of June 30, 2007, we also
have contractual obligations resulting in future minimum payments under
operating leases. A summary of the total future contractual obligations
requiring repayments is as follows (in thousands):
PAYMENTS DUE BY PERIOD
---------------------------------------------
TOTAL <1 YEAR 1-3 YEARS 3-5 YEARS >5 YEARS
--------- --------- --------- --------- ---------
Long-term debt obligations (1) $ 483,583 $ 325,517 $ 158,066 $ - $ -
Capital lease obligations 1,565 608 957 - -
Operating lease obligations 1,359 387 972 - -
Purchase obligations - - - - -
Other long-term obligations (2) - - - - -
--------- --------- --------- ------- ------
Total contractual obligations $ 486,507 $ 326,512 $ 159,995 $ - $ -
========= ========= ========= ======= ======
(1) Long-term debt obligations included in the above table consist solely of
principal repayments. We are also obligated to make interest payments at
the applicable interest rates, as discussed in Note 4 in the consolidated
financial statements, which is incorporated herein by reference. Based on
the amount of debt outstanding and the interest rates as of June 30, 2007,
interest is expected to be approximately $7.1 million during 2007 and $5.6
million during 2008 and 2009.
(2) We have contractual obligations to pay dealer holdback to our
dealer-partners; however, as payments of dealer holdbacks are contingent
upon the receipt of customer payments and the repayment of advances, these
obligations are excluded from the table above.
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are prepared in accordance with
GAAP. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. On an ongoing basis, we evaluate our estimates,
including those related to the recognition of finance charge revenue and the
allowance for credit losses. Item 7 of our Annual Report on Form 10-K for the
year ended December 31, 2006 discusses several critical accounting policies,
which we believe involve a high degree of judgment and complexity. There have
been no material changes to the estimates and assumptions associated with these
accounting policies from those discussed in our Annual Report on Form 10-K for
the year ended December 31, 2006.
27
FORWARD-LOOKING STATEMENTS
We make forward-looking statements in this report and may make such
statements in future filings with the Securities and Exchange Commission. We may
also make forward-looking statements in our press releases or other public or
shareholder communications. Our forward-looking statements are subject to risks
and uncertainties and include information about our expectations and possible or
assumed future results of operations. When we use any of the words "may,"
"will," "should," "believe," "expect," "anticipate," "assume," "forecast,"
"estimate," "intend," "plan" or similar expressions, we are making
forward-looking statements.
We claim the protection of the safe harbor for forward-looking statements
contained in the Private Securities Litigation Reform Act of 1995 for all of our
forward-looking statements. These forward-looking statements represent our
outlook only as of the date of this report. While we believe that our
forward-looking statements are reasonable, actual results could differ
materially since the statements are based on our current expectations, which are
subject to risks and uncertainties. Factors that might cause such a difference
include, but are not limited to, the factors set forth in Item 1A of our Form
10-K for the year ended December 31, 2006, other risk factors discussed herein
or listed from time to time in our reports filed with the Securities and
Exchange Commission and the following:
- Our inability to accurately forecast the amount and timing of
future collections could have a material adverse effect on our
results of operations.
- Due to increased competition from traditional financing
sources and non-traditional lenders, we may not be able to
compete successfully.
- Our ability to maintain and grow the business is dependent on
our ability to continue to access funding sources and obtain
capital on favorable terms.
- We may not be able to generate sufficient cash flow to service
our outstanding debt and fund operations.
- The substantial regulation to which we are subject limits the
business, and such regulation or changes in such regulation
could result in potential liability.
- Adverse changes in economic conditions, or in the automobile
or finance industries or the non-prime consumer finance
market, could adversely affect our financial position,
liquidity and results of operations and our ability to enter
into future financing transactions.
- Litigation we are involved in from time to time may adversely
affect our financial condition, results of operations and cash
flows.
- We are dependent on our senior management and the loss of any
of these individuals or an inability to hire additional
personnel could adversely affect our ability to operate
profitably.
- Natural disasters, acts of war, terrorist attacks and threats
or the escalation of military activity in response to such
attacks or otherwise may negatively affect our business,
financial condition and results of operations.
Other factors not currently anticipated by management may also materially
and adversely affect our results of operations. We do not undertake, and
expressly disclaim any obligation, to update or alter our statements whether as
a result of new information, future events or otherwise, except as required by
applicable law.
28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
Refer to our Annual Report on Form 10-K for the year ended December 31,
2006 for a complete discussion of our market risk. There have been no material
changes to the market risk information included in our 2006 Annual Report on
Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES.
Evaluation of disclosure controls and procedures.
We maintain disclosure controls and procedures that are designed to ensure
material information required to be disclosed in reports that we file or submit
under the Securities Exchange Act of 1934 is recorded, processed, summarized,
and reported within the time periods specified in the SEC's rules and forms, and
that such information is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required financial disclosure.
In designing and evaluating the disclosure controls and procedures, management
recognized that a control system, no matter how well designed and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, with a company have been
detected.
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based
upon that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were effective, at the
reasonable assurance level, as of the end of the period covered by this report
to cause the material information required to be disclosed in the reports that
we file or submit under the Securities Exchange Act of 1934 to be recorded,
processed, summarized and reported within the time periods specified in the
Commission's rules and forms.
Changes in Internal Control Over Financial Reporting. There have been no
changes in our internal control over financial reporting during the quarter
ended June 30, 2007 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
29
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the normal course of business and as a result of the customer-oriented
nature of the industry in which the Company operates, industry participants are
frequently subject to various customer claims and litigation seeking damages and
statutory penalties. The claims allege, among other theories of liability,
violations of state, federal and foreign truth-in-lending, credit availability,
credit reporting, customer protection, warranty, debt collection, insurance and
other customer-oriented laws and regulations, including claims seeking damages
for physical and mental damages relating to the Company's repossession and sale
of the customer's vehicle and other debt collection activities. The Company, as
the assignee of Consumer Loans originated by dealer-partners, may also be named
as a co-defendant in lawsuits filed by customers principally against
dealer-partners. Many of these cases are filed as purported class actions and
seek damages in large dollar amounts. An adverse ultimate disposition in any
such action could have a material adverse impact on the Company's financial
position, liquidity and results of operations.
The Company is currently a defendant in a class action proceeding
commenced on October 15, 1996 in the Circuit Court of Jackson County, Missouri
and removed to the United States District Court for the Western District of
Missouri. The complaint seeks unspecified money damages for alleged violations
of a number of state and federal consumer protection laws. On October 9, 1997,
the District Court certified two classes on the claims brought against the
Company, one relating to alleged overcharges of official fees, the other
relating to alleged overcharges of post-maturity interest and a subclass
relating to allegedly inadequate repossession notices. On August 4, 1998, the
District Court granted partial summary judgment on liability in favor of the
plaintiffs on the interest overcharge claims based upon the District Court's
finding of certain violations but denied summary judgment on certain other
claims. The District Court also entered a number of permanent injunctions, which
among other things, restrained the Company from collecting on certain class
accounts. The Court also ruled in favor of the Company on certain claims raised
by class plaintiffs. Because the entry of an injunction is immediately
appealable, the Company appealed the summary judgment order to the United States
Court of Appeals for the Eighth Circuit. Oral argument on the appeals was heard
on April 19, 1999. On September 1, 1999, the United States Court of Appeals for
the Eighth Circuit overturned the August 4, 1998 partial summary judgment order
and injunctions against the Company. The Court of Appeals held that the District
Court lacked jurisdiction over the interest overcharge claims and directed the
District Court to sever those claims and remand them to state court. On February
18, 2000, the District Court entered an order remanding the post-maturity
interest class to the Circuit Court of Jackson County, Missouri while retaining
jurisdiction on the official fee class. The Company then filed a motion
requesting that the District Court reconsider that portion of its order of
August 4, 1998, in which the District Court had denied the Company's motion for
summary judgment on the federal Truth-In-Lending Act ("TILA") claim. On May 26,
2000, the District Court entered summary judgment in favor of the Company on the
TILA claim and directed the Clerk of the Court to remand the remaining state law
official fee claims to the appropriate state court.
On July 18, 2002, the Circuit Court of Jackson County, Missouri granted
plaintiffs leave to file a fourth amended petition which was filed on October
28, 2002. Instead of a subclass of Class 2, that petition alleges a new,
expanded Class 3 relating to allegedly inadequate repossession notices. The
Company filed a motion to dismiss the plaintiff's fourth amended complaint on
November 4, 2002. On November 18, 2002, the Company filed a memorandum urging
the decertification of the classes. On February 21, 2003, the plaintiffs filed a
brief opposing the Company's November 4, 2002 motion to dismiss the case. On May
19, 2004, the Circuit Court released an order, dated January 9, 2004, that
denied the Company's motion to dismiss. On November 16, 2005 the Circuit Court
issued an order that, among other things, adopted the District Court's order
certifying classes. By adopting the District Court's order, the Circuit Court's
order certified only the two original classes and did not certify the new,
expanded Class 3. On January 13, 2006, plaintiffs filed a motion entitled
Plaintiffs' Motion to Adjust Class 2 Definition to Correspond with Allegations
of Their Fourth Amended Complaint which requested that the "repossession
subclass" be deleted from Class 2 and a new Class 3 be adopted. The Company
filed a response arguing that the new, expanded Class 3 is inappropriate for a
number of reasons including the expiration of the statute of limitations. On May
23, 2006, the Circuit Court issued several orders, including an order granting
plaintiffs' motion and adding the new Class 3. On June 2, 2006 the Company filed
for leave to appeal the Circuit Court's decision to allow the expanded
repossession class as well as its November 16, 2005 certification order. The
Court of Appeals denied the Company's request for leave to appeal the Circuit
Court's decision on August 31, 2006.
In October 2006, the Company and plaintiffs' counsel commenced settlement
discussions, agreeing to use a third party facilitator in face to face
discussions in November and December 2006. These discussions led to the
execution of a February 9, 2007 Memorandum of Understanding whereby the parties
agreed to settle the lawsuit. The Company, without any admission of liability,
agreed to pay $12.5 million in full and final settlement of all claims against
the Company. The Court entered an order preliminarily approving the proposed
class settlement on June 7, 2007. The settlement remains subject to final court
approval.
30
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
STOCK REPURCHASES
Our board of directors approved a stock repurchase program which
authorizes us to purchase common shares in the open market or in privately
negotiated transactions at price levels we deem attractive. On May 24, 2007, our
board of directors authorized the repurchase of up to $30 million of our common
stock in addition to the board's prior authorizations. As of June 30, 2007, we
have authorization to repurchase up to $36.4 million of our common stock. As of
June 30, 2007, we have repurchased approximately 20.1 million shares under the
stock repurchase program at a cost of $391.9 million. Included in the stock
repurchases to date are 12.5 million shares of common stock purchased through
four modified Dutch tender offers at a cost of $304.4 million.
The following table summarizes stock repurchases for the three months
ended June 30, 2007:
TOTAL NUMBER OF MAXIMUM DOLLAR VALUE
SHARES PURCHASED AS THAT MAY YET BE USED
TOTAL NUMBER PART OF PUBLICLY TO PURCHASE SHARES
OF SHARES AVERAGE PRICE ANNOUNCED PLANS UNDER THE PLANS
PERIOD PURCHASED PAID PER SHARE OR PROGRAMS OR PROGRAMS
------------------------- ------------ -------------- ------------------- --------------------
April 1 to April 30, 2007 - $ - - $ 8,631,953
May 1 to May 31, 2007 - - - 38,631,953
June 1 to June 30, 2007 84,254 26.38 84,254 36,409,212
------ -------- -------
84,254 $ 26.38 84,254
====== ======== =======
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our Annual Meeting of Shareholders on May 24, 2007 at which the
shareholders considered the election of five directors. Each of the five
nominees was elected. The following table summarizes the votes for the election:
Nominee Votes For Votes Withheld
------------------------- ---------- --------------
Donald A. Foss 23,219,249 53,241
Glenda J. Chamberlain 23,233,429 39,061
Brett A. Roberts 23,251,909 20,581
Thomas N. Tryforos 23,178,505 93,985
Scott J. Vassalluzzo 23,234,923 37,567
ITEM 6. EXHIBITS
See Index of Exhibits following the signature page, which is incorporated
herein by reference.
31
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CREDIT ACCEPTANCE CORPORATION
(Registrant)
By: /s/ Kenneth S. Booth
----------------------------------
Kenneth S. Booth
Chief Financial Officer
August 2, 2007
(Principal Financial Officer, Principal
Accounting Officer and Duly Authorized Officer)
32
INDEX OF EXHIBITS
EXHIBIT
NO. NOTE DESCRIPTION
------- ---- ---------------------------------------------------------------------------------------------------
4(c)(19) 1 First Amendment, dated as of September 20, 2006, to Fourth Amended and Restated Credit
Agreement, dated February 7, 2006, between the Company, the Banks which are parties thereto
from time to time, and Comerica Bank as Administrative Agent for the Banks.
4(c)(20) 1 Second Amendment, dated as of January 19, 2007, to Fourth Amended and Restated Credit
Agreement (the "Revised Credit Agreement"), dated February 7, 2006, between the Company, the
Banks which are parties thereto from time to time, and Comerica Bank as Administrative Agent
for the Banks.
4(c)(21) 1 Third Amendment, dated as of June 14, 2007, to Fourth Amended and Restated Credit Agreement
(the "Revised Credit Agreement"), dated February 7, 2006, between the Company, the Banks which
are parties thereto from time to time, and Comerica Bank as Administrative Agent for the Banks.
4(f)(87) 2 Indenture dated April 12, 2007 between Credit Acceptance Auto Dealer Loan Trust 2007-1 and
Wells Fargo Bank National Association.
4(f)(88) 2 Sale and Servicing Agreement dated April 12, 2007 among the Company, Credit Acceptance Auto
Dealer Loan Trust 2007-1, Credit Acceptance Funding LLC 2007-1, and Wells Fargo Bank, National
Association.
4(f)(89) 2 Backup Servicing Agreement dated April 12, 2007 among the Company, Credit Acceptance Funding
LLC 2007-1, Credit Acceptance Auto Dealer Loan Trust 2007-1, Wells Fargo Bank, National
Association, and XL Capital Assurance Inc.
4(f)(90) 2 Amended and Restated Trust Agreement dated April 12, 2007 between Credit Acceptance Funding
LLC 2007-1 and U.S. Bank Trust National Association.
4(f)(91) 2 Contribution Agreement dated April 12, 2007 between the Company and Credit Acceptance Funding
LLC 2007-1.
4(f)(92) 2 Intercreditor Agreement dated April 12, 2007 among the Company, CAC Warehouse Funding
Corporation II, Credit Acceptance Funding LLC 2006-1, Credit Acceptance Auto Dealer Loan Trust
2006-1, Credit Acceptance Funding LLC 2006-2, Credit Acceptance Auto Dealer Loan Trust 2006-2,
Credit Acceptance Funding LLC 2007-1, Credit Acceptance Auto Dealer Loan Trust 2007-1,
Wachovia Capital Markets, LLC, as agent, The Bank of New York (as successor-in-interest to the
corporate trust business of JPMorgan Chase Bank, N.A.), as agent, Deutsche Bank Trust Company
Americas, as agent, Wells Fargo Bank, National Association, as agent, Comerica Bank, as agent.
31(a) 3 Certification of Chief Executive Officer, pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934.
31(b) 3 Certification of Chief Financial Officer, pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934.
32(a) 3 Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350 and Rule
13a-14(b) of the Securities Exchange Act of 1934.
32(b) 3 Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350 and Rule
13a-14(b) of the Securities Exchange Act of 1934.
1 Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated June 14, 2007, and incorporated herein by reference.
2 Previously filed as an exhibit to the Company's Current Report on Form
8-K, dated April 12, 2007, and incorporated herein by reference.
3 Filed herewith.
33